If you're trying to get a pulse on the chip industry -- which in many ways is a proxy for the global economy overall -- there's no better company to closely watch than Taiwan Semiconductor Manufacturing (TSM -2.26%), often referred to as TSMC. The company was a recent addition to Warren Buffett's stock portfolio via Berkshire Hathaway, but long before that, TSMC was an incredibly important business. It controls the bulk of the world's chip fabrication (fab) capacity, chips being the driving force behind all things in computing technology.
Thus it's notable news whenever TSMC provides a quarterly earnings update, let alone a future outlook on the health of the tech manufacturing market. And based on the recent update, investors looking for a deal should give this stock a serious look right now.
Capping off another record year
TSMC just put the final wrap on an incredible 2022. Revenue for the full-year 2022 was $75.9 billion, and net income had a whopping 45% profit margin at $34.1 billion.
In the fourth quarter specifically, revenue was up 43% year over year in Taiwanese dollars, although negative currency exchange rates due to the incredible strengthening of the U.S. dollar (a result of the Federal Reserve's interest rate hikes) lowered year-over-year revenue growth to "only" 27%, coming in at $19.9 billion. Q4 net income was $9.4 billion. All financial results in the last year were elevated well above TSMC's goals through 2026, which have been targeting average annual revenue growth of 15% to 20% in U.S. dollar terms.
TSMC closed out 2022 with cash and short-term investments of $50.8 billion and debt of just $27.8 billion, an absolute rock of a balance sheet that dividend stock investors dream of.
A slowdown looming large?
As good as these results were, though, semiconductor investors know that a brutal downturn is currently in effect for the industry. Consumer electronics spending, in particular, is driving this downturn as households pare back spending on PCs, laptops, and smartphones after frantic purchasing due to work-from-home effects early in the pandemic. Key TSMC partners like Nvidia, Advanced Micro Devices, and Qualcomm have taken a hit, though for now, it seems top customer Apple has been far more stable due to perennial demand for new iPhones.
A number of these customers have indicated the current downturn should end sometime around the middle of 2023. This cyclical downturn is affecting TSMC too. The forecast for the first quarter of 2023 is for revenue to be in a range of $16.7 billion to $17.5 billion, down sequentially from Q4 2022 and down as much as 5% from the $17.6 billion reported in Q1 2022. Profit margins will fall as well, with operating margin expected to be in a range of 41.5% to 43.5%, compared to 45.6% the year prior.
Don't sleep on the chip market for too long
This immediate-term outlook shouldn't cause too much worry, though. TSMC added credence to the other chip company calls for the current downturn to quickly come to an end. TSMC management said on the earnings call it expects a bottom to be complete by the middle of 2023, and in fact said it still expects full-year 2023 revenue to be up slightly (in U.S. dollar terms) versus 2022.
This is an incredible testament to TSMC's huge leadership in chip manufacturing. Though revenue and profit growth will likely plateau at best over the coming quarters, this is a compelling stock right now. Shares currently trade for just under 14 times trailing-12-month earnings per share and just over 26 times trailing-12-month free cash flow. The two valuation metrics should converge and possibly meet in the middle in the coming year -- due to depreciation and amortization expense rising (which will raise the price-to-earnings ratio, all else being equal) and free cash flow increasing (due to a slight pullback in capital expenditures in 2023).
Given this outlook, TSMC looks like a value at this juncture -- assuming the chip industry pulls out of its slump in the second half of 2023 and sustains a new run higher through 2024 and beyond. This isn't my favorite chip manufacturing play (my personal nod goes to ASML Holding, a top equipment supplier to TSMC). However, TSMC fans would probably do themselves right by making a purchase (or adding to an existing position) at this juncture while the semiconductor market finds a bottom.
